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Central Banks Urged to Study Digital Currency Risks and Rewards

(Bloomberg) -- Digital currencies are a revolutionary tool that central banks should consider, but they remain far too risky to be used as legal tender any time soon, according to the Bank for International Settlements.

The BIS -- the club of the world’s largest central banks -- said in a report on Monday that the new form of money could one day be issued by policy makers for tasks such as settling payments among financial institutions. At the same time, it warned that digital coins might destabilize traditional lenders if offered widely to the general public.

“General-purpose central-bank digital currencies could revolutionize the way money is provided and the role of central banks in the financial system, but these are uncharted waters,” said Benoit Coeure, a European Central Bank board member who chairs the BIS Committee on Payments and Market Infrastructures.

The Basel, Switzerland-based BIS cautioned that much more “experimentation and experience” would be needed before the introduction of central-bank digital currencies, or CBDCs, could even be considered.

G-20 Debate

As Bitcoin and its peers threaten to invade central bankers’ home turf, national authorities are probing new ways of making payments, and the topic of regulation is on the agenda of Group of 20 finance chiefs who will meet next week in Buenos Aires.

More than 1,200 years after the first paper banknotes appeared in China, the use of physical cash is in demise in various countries as digital transactions surge. The rise of distributed-ledger technologies and the peer-to-peer concept of private digital money challenges the raison d’être of central banks, which for centuries have dominated currency issuance and paid their bills by doing it.

Opinions about issuing CBDCs diverge greatly. While Federal Reserve Chairman Jerome Powell and Bank of England Governor Mark Carney have expressed skepticism, the Riksbank in Sweden, where more than a third of the population never uses cash, is considering the introduction of an e-krona as a complement to banknotes and coins.

The BIS concluded that wholesale digital currencies and their underlying technologies have the potential to make settlement of securities and derivatives transactions more efficient, even though proposals so far look broadly similar and not clearly superior to those in place.

Likewise, digital currencies could serve as a “robust and convenient” alternative to cash, but already available, fast and efficient retail payment products -- such as the European Central Bank’s TIPS -- probably limit its benefits.

The issuance of CBDCs probably wouldn’t change the basic mechanisms for carrying out monetary policy, the BIS said. However, it could challenge the two-tier banking system and exacerbate any financial crisis as depositors seek havens for their cash.

A CBDC “could allow for ‘digital runs’ towards the central bank with unprecedented speed and scale,” the BIS said. “Even in the presence of deposit insurance, the stability of retail funding could weaken because a risk-free CBDC provides a very safe alternative.”

Cyber Risk

The appeal of a such a currency would be more pronounced if it were interest-bearing. A liquid and creditworthy asset could compete with short-term government debt and regular bank deposits, potentially leading to more volatility in those financial-market segments, according to the report.

The BIS also highlighted that, like banknotes, digital currencies can fall victim to illegalities -- as a direct target or a means of transaction.

Coeure indicated on a conference call with reporters that the initiative to regulate private cryptocurrencies, led by Germany and France, probably won’t immediately result in concrete action.

The BIS urged central banks to continue their studies of digital innovations and also consider the implications of not issuing CBDCs. The Fed’s Powell said last year that “governance and risk management will be critical” for cryptocurrencies.

“Technological developments have raised questions about the feasibility and desirability of combining distributed ledger technology with the trust inherent in fiat currencies to create a central bank digital currency available to all,” Carney, who chairs the BIS’s Global Economy Meeting and the Financial Stability Board, said in a statement alongside the report. “The policy issues that this would raise, for central banks and society more generally, need careful consideration.”